Tariff After Tariff: If This Is An Actual Trade War, Who Is Likely To Emerge Victorious?

Are we heading towards a trade war? The steel and aluminium tariff, Gary Cohn’s resignation, threats of tariffs on China and President Donald Trump’s tweet “trade wars are good”, Beijing retaliating by planning tariffs on about $3 billion in imports including 15 per cent tariff on US steel pipes, fresh fruits and wine and 25 per cent on pork and recycled aluminium; definitely are more than JUST an indication. During his election campaign Trump emphasised a lot on putting America first. He was not only particularly critical of China and Mexico (USA’s largest trading partner) but also of multilateral trade agreements like North American Free Trade Agreement (NAFTA) etc. Right from the time of American election days, economists have feared trade war as potential threat to the world. The recent events can change the potential threat into reality.

Economists are generally of belief that trade wars are always damaging. Robert Mundell in his classic work said that in a world of flexible exchange rates, import tariff imposed by the US will lead to appreciation of dollar via improving the balance of payment, which can lead to decline in the overall output and employment for the US despite small benefits from tariff. In 2016, IMF estimated that 20 per cent tariff by the US on imports from East Asia would raise dollar by 5 per cent and decrease the US output by 0.6 per cent over five years. These are standard macroeconomic results, displaying economists’ belief in free trade. According to these results restriction on trade can be self destructive for the US.

The bigger question is who wins in a trade war? Economic theory, like for most questions, doesn’t have any straight forward answer to it, and the conclusion depends on many ifs and buts. But if history is any guide, then the answer is NO ONE. The most infamous example is Smoot-Hawley Act 1930. This act led to increase of US tariff by 20 per cent on average to protect the interest of farmers, but other industries lobbied for protection soon and the rate of tariff increase further. Demand collapsed worldwide, countries rushed to maintain their gold reserves either by devaluing their currency or imposing more trade barriers. President George W Bush raised steel tariff in 2002, which led to US gross domestic product falling by $30.4 million and 200,000 losing their jobs. Victory of any group in the trade war is not guaranteed but consumers are going to be the certain losers. Consumers have been the clear beneficiaries of globalisation. Cheaper goods have entered into North America at very high rate. In very simplified scenario consumers have benefited but definitely this ignores some complications.

Why is President Trump inviting a war? His rationale is simple; he wants to improve the balance of trade, which has been in deficit for many years. Also, it is a politically correct move for attracting voters in America’s rust belt. Rust belt is the manufacturing belt of America, and the steelmakers in the area feel their plants have been ruined by global overproduction mainly from China, which has depressed prices. The problems gets further aggravated by higher wages in the US, legacy pension plans which put pressure on balance sheets of firms, higher power cost, stiff environmental regulations etc. These factors point that the problems with US steel producers is not all external but domestic as well. Another big problem is related to automation. Nucor CEO John Ferriola said on 1 March after meeting with President Trump that the tariff would allow his company to increase investment with more rapid rate which would mean more jobs. However, even if more production shifts to US, experts believe that the way industry has been embracing automation, it’s unlikely that modern steel plants are going to mass employers that they once were.

Some people share this belief that the trade was started by China many years ago, not by President Trump. These people point to the predatory trade practices followed by China like restricting access to Chinese markets, providing advantage to its firms at the cost of others, forcing US businesses to transfer technology to Chinese firms. Experts like Rob Atkinson says that most foreign companies trading with China face discriminatory practices, but are reluctant to complain as they fear retaliation such as being investigated for antitrust, consumer abuse etc. This, in addition to the fact that system in China is so opaque, leads to lack of evidence typically required for a WTO case. So, they see Trump’s action as an effort to correct malpractices in Chinese trade practices.

How is all this going to impact India? As correcting trade deficit is the primary aim, let’s see it from that perspective first. India is not an important player in world trade, so trade war should not affect Indian interest directly. US runs trade deficit with almost all its trading partners. But India is not its significant trading partner, with 1.9 per cent share India is ninth largest trading partner. Trade between USA and China is in favour of China with surplus of $375 billion but with Indian trade surplus with the US is meagre $22.9 billion. In sectorial analysis of trade we find that the US runs trade deficit mainly in the sector like telecommunications equipment, electrical equipment, accessories for motor vehicles etc, where India is not an important player. The global trade tension can affect liquidity in the Indian equity markets, affecting the Indian exchange rate as well and that can affect Indian interests.

IMF in its World Economic Outlook April 2017 also mentioned turning towards protectionism as a salient threat. We need to be concerned as this may trigger a series of impacts like retaliation by other countries maybe by our important trading partners, impact on world GDP growth, uncertainty in global financial markets etc, which might be detrimental to India’s export ambitions in the near future. This also reinforces the above mentioned point that we may all end up on the losing side!